In association with Travelport
What a difference just 12 months make.
This time last year we were all holding our collective heads in our hands, despairing of the UK economy in general, and Thomas Cook in particular.
Now everything has changed; the UK is much touted as the safe haven economy in Europe, and Thomas Cook has just brought out well-received numbers.
Even better, 2014 looks like it could be a vintage year for summer bookings. Festive cheer is finally in ample supply.
Rather than focus again on the UK – more on that next month in January – I thought I’d try to see what links two major travel giants together, Accor and Carnival, both of which have been fairly busy in the last few weeks.
There’s a number of inter-linking themes lurking around of which I’d highlight three – the need to broaden customer reach especially to younger customers, the (falling) price of oil and, most importantly, the dawn of a new age of capex caution which will favour the very biggest scale operators.
I’ll come to the price of oil and the need to reach the vast ‘millennials’ audience later in this article, but let’s start with that capex point.
Put simply, we’re about to enter a new age where the cost of capital will start rising within the next 12 months.
For most small businesses this slightly worrying new world is wearily familiar – they’ve been locked out of cheap credit markets since the global financial crisis.
But for the true leviathans of the travel industry, credit has been astonishingly easy to access – even for Thomas Cook, although it has had to work a bit harder than its peers.
More to the point, this easy liquidity has been accompanied by rock bottom rates in recent years.
Within a few months the US Federal Reserve bank will start tapering its support and a cold realisation will dawn on the credit markets, namely that too many big companies have been gauging on cheap credit to fund share buy backs, finance terrible M&A activity and help boost cash reserves.
As that realisation sinks in, we’ll see the effective net cost of capital rise noticeably.
That will have a series of knock-on effects, not least that already much diminished capex spends will be tightened even further unless there’s evidence of strong and robust global growth which might act to open CFOs cheque books.
This change will mean that more and more projects will be scrutinised very carefully.
The rising cost of capital will eventually also have an impact on corporate interest rates, forcing the most heavily indebted companies to pay more for their debt.
Yet this greater focus on capital will coincide with a fascinating moment in the evolution of the travel industry – significant advances in engineering and industrial processes are yielding significant incremental gains in energy efficiency (and digital marketing technology to boot).
The new generation of efficient planes for instance can cram in more people and use less fuel, delivering noticeable year-on-year productivity improvements.
The same goes for the big cruise operators like Carnival. Their vast new mega-ships are absolute game changers, allowing big margin improvements year on year over the next two decades.
Now all this extra capacity in terms of shiny new planes and ships might possibly come at exactly the wrong moment, as consumer demand slips back again, pushing both sectors into margin destruction, but my wager is that won’t happen – we’ll want more flights and cruises not less.
But these big gains from new engineering technologies will probably only really benefit the very biggest players who have the sound credit ratings and deep pockets to fund this spending, giving them an unfair advantage.
Take Flybe, for instance, in its battle against the likes of Ryanair and EasyJet – every new plane delivered to the big LCCs gives them a small 1% or 2% technological incremental advantage every year, year in, year out.
Flybe must thus work double time to catch up or ratchet up its debt levels to spend on new planes. Either way it faces a massive struggle. The same goes for Carnival’s more limited range of competitors who are effectively caught on a capacity race with Carnival and its huge balance sheet.
All of these changes won’t necessarily seem quite so drastic over the next few years because they’ll be obscured by relatively decent global growth and helped along by oil prices – which could fall very substantially in the next six months, with Brent crude prices now likely to hit $90 or less if consensus numbers are to be believed.
That’ll mean that although everyone’s ‘boats’ will rise gently, so to speak, in truth boats belonging to the very biggest companies will rise fastest, giving the dominant scale player in each sector a major advantage.
Which brings us nicely to Carnival’s recent trading numbers which were poorly received by the market.
Carnival under its new chief executive Arnold Donald is having a torrid time at the moment, for a whole bunch of obvious reasons. Onboard disasters, evidence of overcapacity, and failure to reach valuable new demographic segments.
The recent third quarter results confirmed this underwhelming big picture, with Carnival generating revenues of $4.73 billion, up just 0.9% on the year before, while net income fell from $1.33 billion last year to $934 million.
Although revenue growth increased by a modest 0.9%, Carnival reported a 3.8% fall in net revenue yields.
Digging into the numbers we see that costs have been increasing as costs per available berth day increased by 4%. Also a 2.3% increase in fuel prices was offset by a 5.2% decline in fuel consumption as initial efficiency investments start to pay off.
Carnival’s overall operating margin fell to 20.2% from 27.2% last year, which would suggest that the cruise giant with its 100 ships is using price discounting to keep up capacity growth. Numbers from analysts at Barclays suggest that the average cost of a Carnival brand cruise is down 15% this quarter from a year earlier.
Perhaps most importantly the company was remarkably cautious on the outlook for the remainder of the year and into 2014, predicting that profits would be ‘soft’ for the coming first half, especially as the cost of new ships and extra marketing kicks in. Net revenue yields for the remainder of 2013 for instance are expected to fall by 3%.
Given these numbers it’s no surprise that Carnival’s share price has been becalmed for quite some time, stuck in a $30 – $50 price range. But Carnival is nevertheless the juggernaut that everyone else in its sector has no other choice than to keep up with especially as its new ships are introduced next into the Asian market.
Every shiny new ship, with record fuel efficiency and passenger capacity forces its competitors to borrow more, just as the cost of capital starts to increase – pushing them into more debt. All Carnival has to do now is cross its fingers and hope it’s surge in efficient new capacity can be paid for by pushing cashflow up by discounting tickets – hopefully 2014 will bring the expected surge in demand from the US and Asian markets.
Remember that only 24% of the US population has ever taken an ocean cruise and the passenger capacity of all the cruise ships in the world amounts to less than half the number of visitors to Las Vegas.
I’m inclined to agree with the most recent view from analysts at the vampire squid bank Goldman Sachs who whilst recognising that Carnival faced structural challenges based on increased capacity, still believed it will benefit from a new management strategy and an upturn in Asia and Europe.
The Millennial Opportunity
In my simple world view Carnival had two big opportunities. Firstly it should use its strong balance sheet to power a sustained increase in capital spending just as the cost of capital increases – thus benefiting in the future from big margin advantages as consumer demand increases.
The other big item of spending (easily affordable given the cash on the balance sheet and the cheap debt issued in recent years) is on new digital media spending, which will gobble up vast amounts of money.
Perhaps the biggest opportunity here is to spend big on new digital channels that allow Carnival to reach hundreds of millions of customers using simple social campaigns. In particular Carnival also has to use its sustained increase in capacity as a way of wooing more younger cruise customers, especially those from the millennial generation.
Carnival has already recognised this challenge and is spending a bucket load of money to get younger cruise customers on to its ships, but this will cost it many tens of millions in new digital media and IT spend.
As Thomas Cook is discovering, the new world of multiple digital channels, requires a quantum leap in IT spending which has to be funded out of capex budgets. Now to be fair to Carnival, it can do simple things that don’t involve spending countless tens of millions on new IT channels, starting with the simple strategy of running more shorter cruises, of say 4 to 5 days length. It could also use clever branding to distinguish distinct sub brands to drive traffic to younger customers.
But to really win over Generation Y millennial customers it has no other choice than to spend money on digital media and making sure that these new global sales channels integrate effortlessly with its existing legacy IT systems.
At this point it’s important to say that despite the hype, most of those Millennial customers its likely to be chasing aren’t that different from every other generation of young people – the excited talk about fundamentally different behaviour patterns is largely patronising rubbish.
In my twenties and thirties I can distinctly remember all my peers being a) impoverished and keen to save money b) collaborative by sharing information with their mates and c) caring enormously about not wasting money by going to places that all my friends thought was terrible. Oh and while we’re at, most of my peers also had a short attention span and cared more about the environment. Plus ça change, plus c’est la même chose.
Yet there has been one crucial change – we’ve seen an explosion of communication channels, with a veritable cornucopia of sources for the IT literate generation. Now consumers can use their mobile devices for speed of booking and last minute ideas.
Younger consumers can share content and ideas with their mates in the blink of an eyelid. And, crucially, younger consumers are becoming much more brand savvy, with a need to see what the location is like using video as an absolutely essential. They might still use a travel agent if they need help, but they’ll augment their knowledge by new information sources.
This forces travel groups like Carnival to invest in two very expensive essentials. The first is a massive IT reboot of their corporate structure, integrating traditional enterprise management systems with new digital channel sales channels.
Carnival has already simplified its fare structure, made enhancements to its travel-agent website and created a new bonus program for salespeople but it’ll now have to spend a huge amount of money on integrating video and social media into its sales channels.
But all the new digital channels in the world won’t help if you have a crap reputation in terms of brand – as Ryanair might just concede. To be fair, Carnival has a series of very mainstream brands that are well respected, if not entirely sexy – that’ll have to change that.
They’ll need to up their spending on brand/s and that means more than just a new logo. It means maybe thinking about sub brands, with distinct product offerings and different price points. This wave of brand innovation has already swept through the hotels industry and is now about to smash into Carnival.
The Accor switch
It’s against this back drop that we finish with a flourish, focusing on the sudden change of heart by massive French hotels group Accor.
In case you missed it new chief executive Sebastien Bazin (who joined just three short months ago from major investor Colony Capital) has decided to execute a stunning u-turn. The old idea at the hotels giant had been to slowly cut its capital requirements and sell hotels.
That plan has now been junked and Bazin wants to split Accor into two business units – a hotel services unit that will operate the hotels (called HotelServices) and a property management business called HotelInvest.
The HotelServices unit will be a pure fee-oriented operator and franchisor, operating 3,600 hotels comprising 460,000 rooms globally under 14 brands. The portfolio will consist of 46% of properties in the economy segment, 40% in the midscale segment and 14% in luxury or upscale.
This will be a service-orientated business with a focus on profits and the P&L. Crucially a focus of this new business will be on “customer relationship management, loyalty and digital marketing”.
The HotelInvest business will be balance sheet-driven and will in effect be Accor’s ownership and investment arm and will start with a portfolio of approximately 1,400 hotels, of which nearly 300 are fully owned by Accor.
Here’s Bazin enplaning his bold move: “We’ve seen a profound change in our customer expectations, and it’s a result of the digital revolution in our industry. Our customers have become increasingly international and diverse in their expectations, which are constantly changing.”
The cynic might suggest that Accor’s Bazin had no other choice than change tack, especially as its peers have clearly done a better job of defining their product propositions (and balance sheets) over the last few years.
Competitors such as InterContinental Marriott and Starwood have adopted an asset lite business model, generating higher profitability and returns on invested capital via franchised hotels or management contracts. Accor achieved an operating margin of 9.3% last year, whereas InterContinental (where less than 1% of its property is owned directly) has a margin of 33%.
Most investors also didn’t seem to be too enthralled by the absence of radical cost cutting and the certainty of more corporate upheaval. “The new strategy doesn’t exactly meet market expectations,” analysts at Societe Generale noted. “The market was looking for a cost cutting plan and an acceleration in changes.”
The shares also dropped 7.5% on the day the news was released as investors realised that Accor would not be returning more than €1 billion in capital to its shareholders in the next few years.
Yet I’d suggest that Accor has probably noticed a change in sentiment. It needs to hive off that capital intensive business into a unit that can more easily keep tab on returns on capital in my fast approaching new world of more expensive capital.
Crucially its core HotelServices unit can now spend huge amounts of money on new digital marketing, rebranding and reaching new demographics who might not think of using one of its hotels.
If I’m right we should expect Accor to be pushing much more aggressively to use its growing number of digital channels to reach millennial customers in particular over the next year.